If you decide to forgo traditional investment, such as taking out a loan from a financial institution, you may find yourself in the world of equity investors. An equity investor actually buys a portion of your business and, for better or worse, is a part owner in your enterprise. This can be a very good thing or a very bad thing, so it's important to know what you're getting yourself into.
An equity investor is prepared to lose all of his or her investment into your company. If the business fails, the equity investor knows that there is little chance of getting any of their money back. As a result, equity investors often ask for a fairly high percentage of a company's profits or other benefits to make up for the substantial chance of loss. There's also a good chance that the investor will want salaries capped, especially in the beginning, so always consider how much of your company's hard earned profits you're willing to give away and whether you can afford to have your salary capped.
Although equity investors usually demand a significant portion of the business profits and they have considerable leverage, there's always room to negotiate. Before seriously negotiating, determine for yourself just how much you're willing to give away to investors before equity investing no longer seems attractive compared to traditional financing options for your business.
One of the most contentious points between business owners and equity investors is how much control equity investors will have in the company. Don't think of these rights as simply ceremonial or there to appease. Equity investors often exercise their rights, including voting the company's founder right out of the company. Rights that equity investors may end up with include:
Giving an equity investor substantial rights to your company does not have to be a negative thing. Often, equity investors have years of experience and can be a significant source of advice and information.
There are several ways to structure your business along with your equity partners. Take the time to figure out which business entity works best for you:
Stock from a corporation, partnership interests and LLC membership are treated as "securities" by the law. There are a host of securities laws, both state and federal, that regulate the sale and exchange of securities. No matter what kind of business organization you setup, you need to become familiar with the set of securities laws that apply to you.
For example, find out whether you are exempt from most securities requirements. Small businesses of a certain size will typically be allowed to provide equity investors with an interest in the business without having to fill out and file complicated paperwork. Be aware that if you are not exempt, complying with securities laws can cost a significant amount of money, so make sure it's worthwhile to bring in equity investors if you aren't exempt from securities laws.
The other major component of securities laws governs what you need to disclose about your business and who you need to disclose to. If you are ever unsure, contact an attorney and always err on the side of caution by disclosing items that you may be uncertain about.
Hiring an Attorney to Help with Equity Investors
When negotiating with equity investors, you need to be sure you understand your legal rights and obligations. Contact an experienced business law attorney to help you understand what to expect when entering into any such formal business relationship.